What you will learn
- Tell the bid from the ask when you look at a quote
- Work out the spread and see how it becomes a trading cost
- Use the spread to get a quick sense of an asset's liquidity
- Find the mid price and explain why it is a reference, not an actual trade price
Remember the small gap between the best buyer and best seller in the order book? That gap matters every time you trade. A stock does not have one price at any given moment. It has a price at which you can sell and another at which you can buy.
What is the bid-ask spread?
The walkthrough connects the two quoted prices to the order book. Pay attention to why the spread costs you money even when you pay no commission.
Two prices on every quote
- The bid is the highest price a buyer will pay right now.
- The ask, sometimes called the offer, is the lowest price a seller will take right now.
- The ask is always above the bid. If they met, a trade would happen at once and the gap would close.
Key terms
- Bid
- The best price currently offered by a buyer. When you sell at market, you sell at the bid.
- Ask (offer)
- The best price currently offered by a seller. When you buy at market, you pay the ask.
- Spread
- The distance between the ask and the bid. Subtract the bid from the ask to find it.
- Mid price
- The average of the bid and ask. It gives you one reference price, though no one trades at that exact price.
Calculate the spread
A stock has a bid of $49.98 and an ask of $50.02. How wide is the spread in dollars?
How the spread costs you money
You buy at the ask and sell at the bid. Suppose you buy one share, change your mind a second later, and sell while the quote stays put. You paid the higher price and sold for the lower one, so you lost the spread without the stock moving at all. That loss is a trading cost. It also pays market makers for being ready to take the other side of a trade. A narrow spread is cheaper to cross than a wide one.
A quick round trip
The bid is $49.98 and the ask is $50.02. You buy 100 shares, then sell all 100 right away. The quote stays the same. How much did the spread cost you?
- Buy at the ask. At $50.02 per share, 100 shares cost $5,002.
- Sell at the bid. At $49.98 per share, the sale brings back $4,998.
- Find the difference. You paid $5,002 and received $4,998. That is a $4 loss even though the quote never changed.
Why it matters: For an immediate buy and sell, multiply the spread by the number of shares. Repeat that trade often in stocks with wide spreads, and the cost grows quickly.
If you buy now, you pay the ask. If you sell now, you get the bid. The gap is part of your cost.
What the spread says about liquidity
The spread gives you a quick read on liquidity, or how easily you can trade an asset without moving its price. Heavily traded assets, such as major currencies and stocks in large companies, may have spreads of a penny or less. A thinly traded small company or unusual instrument may have a spread of many cents, or even a few percent of its price. Between two stocks, the one with the tighter spread is usually easier and cheaper to trade.
| Asset | Usual spread | Likely trading conditions |
|---|---|---|
| Stock in a large company | About one cent | Very liquid and cheap to trade |
| Stock in a midsize company | A few cents | Fairly liquid |
| Small stock with little trading | Many cents or a percent | Harder and more expensive to trade |
Compare two spreads
Stock A trades near $50 with a one cent spread. Stock B also trades near $50, but its spread is forty cents. You will buy and later sell the same dollar amount. Which stock should cost less to trade?
Stock A is cheaper to trade. Its one cent spread leaves you with a much smaller cost when you move between the ask and bid.Bid price vs ask price, and the spread explained
More examples show how the spread becomes a cost. Use them if you want another look at the idea.
Why market makers earn the spread
A market maker offers to buy from you at the bid and sell to you at the ask. In one or two sentences, explain why the spread is payment for that service.
Write an answer before comparing it with the model response.
Model answer
A market maker must keep quoting prices, hold shares in inventory, and take the risk of trading with anyone who shows up. The spread pays for that work and risk while giving other traders someone to trade with right away.
The spread will show up again throughout this course because it affects the cost of every trade. Your next choice is how to place the order. That choice helps determine whether you cross and pay the spread or place an order that may earn it.